3 Options for how you can start your investing journey

You’ve checked off all the necessary boxes to start your investing journey. Now, you just have to start investing. But you don’t know what that actually means, what ways you can invest, or what you’re supposed to do. Does that sound right?

The simplest way to describe starting out your investing is to break it down into three general paths. These are three manners in which you can start investing, ranging from finding help for everything to doing everything yourself.

Those three options are:

1. Indexing, i.e. investing in index funds
2. Finding someone you can trust to invest for you
3. Learn how to invest actively yourself

Let’s dig into those in more detail, starting with the most boring and also wisest option:

Indexing

An index is a list. In the stock market, an index is an instrument that lists and tracks the share prices of a collection of stocks. And index as a verb is investing in the index as your primary investing.

The most famous index is the Dow Jones Industrial Average, which tracks the prices of 30 of the largest companies in the U.S. Like many things that are most famous in their field, the Dow Jones Industrial Average is not very useful. The companies it holds are not so representative of the modern market, and the way it calculates its value is by the prices of the companies’ shares, which is not very useful.

The two well-known but more relevant U.S. indices are the S&P 500 and the Nasdaq Composite. When I talk about indexing, I usually mean investing in funds that track the S&P 500. This index tracks the value of 500 of the biggest companies in the U.S. It averages them by their capitalization, meaning the value of the companies’ stocks. This is more useful.

The S&P 500 is also the best benchmark of how ‘the market’ is doing, and how other instruments or investors are doing compared to the market. If I say I’m beating or lagging the market, I usually mean the S&P 500.

The Nasdaq Composite is a flashier, more volatile index, full of faster-growing companies with more of a tilt to the technology sector. The Nasdaq is also capitalization weighted, and a Nasdaq index fund is a viable alternative or supplement to the S&P 500. But we start with a focus on the S&P 500.

Benefits of indexing

Why index?

First, you will only get average market returns, but average returns over time are good. Let’s take one of the worst starting points in this millennium, January 1, 2000 – right before the dot com crash, when pets.com puppets and beanie babies still held value.

If you invested $100 in the S&P 500, you’d have $424.59 by the end of 2022 according to officialdata.org, a return of 6.5% a year. This is a worst-case scenario. Over the last century, the S&P 500 has returned around 10% a year. I talk about expectations in our mindset post, but that’s a reasonable range to keep in mind.

The other reason indexing is attractive, and why other options are tough, is that indexing is cheap. To index you buy an exchange traded fund, or ETF – and we’ll talk about this more in the indexing post – and that fund has a manager. But that manager charges as little as .03%. So on that $100, you would be paying $.03 a year. Lower fees are, all things equal, better.

Indexing is also easy. You need to set up a brokerage account, pick the right index fund or funds, make your initial purchase, and then continue buying over time, and that’s it.

You don’t have to analyze the economy or the market or individual companies in this strategy. Indexing works because over time, the markets tend to go higher, and passively buying into the market via an index fund gives you access to that growth.

That’s not a guaranteed return, but since the start of the millennium, the only times that the S&P 500 has been negative for three years has been the three year stretch from September 2001 to September 2004 – after the dot com crash and 9/11 – and the less than three year stretch from September 2008 to June 2011 – right after the great financial crisis. Oh, and the two worst days of the initial pandemic sell-off in March 2020. If you held past those periods, you would have made a positive return in any other 3-year or longer timeframe. Not a bad track record as long as you have time on your side.

Cons of indexing

There are some cons to indexing, but not many.

1. You do actually have to set up your account, buy the shares initially, and then buy more shares over time. That involves some work. Not a lot, but you have to be comfortable taking charge of a financial decision like this.

2. You are consigning yourself to average returns. Average returns in the stock market are pretty good (see the previous section)! But you won’t be able to brag about this at parties. If you’re curious about beating the average, your curiosity won’t be satisfied here.

3. The most important con – you have to make sure you don’t panic when things get bad. Average returns are pretty good over time, but in 2022 the S&P 500 dropped almost 20%. In March 2020, the S&P 500 plummeted. For you to index successfully, you have to not only ignore the bad feelings that lower prices can evoke, but be comfortable sticking to your plan and buying more shares. If you have the stomach for that, indexing is probably your best option. If not, you may want to consider the next option I cover.

It’s my opinion that indexing is the most practical option for most people. But you don’t need to take it from me. “Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees.“

Source: CNBC

Warren Buffett, one of the greatest investors of our and any time, is the one making that case. I agree with him.

Find someone you trust to invest for you

Let’s say you don’t have the stomach for a March 2020 environment, or don’t want to spend any time thinking about it, or you just want someone to hold your hand. This is where working with an investment advisor of some sort can make sense.

Investing is not complicated, but it takes discipline and experience to know how to hold through the ups and downs – over the long term stocks go up, but in any day or year, they are liable to drop. So an experienced hand can hold yours and make sure you don’t get off the ride at the bottom.

Benefits of investing with a professional

The biggest benefit is that you can just forget about your investments. You might sleep better at night knowing you have someone in charge of your financial future. As much as investing is about money, it’s also about time – if someone can save you time and anxiety, that could be worthwhile.

If you are more curious about the market, an advisor might also be able to teach you about the process. They may be in regular communication with clients about the market and their investing decisions, but they also may be a resource should you have specific questions.

Cons of investing with a professional

The flipside to those benefits are the costs of working with a professional.

First, you need to be able to trust them. That’s not just assurance they won’t cheat you – most people won’t – but also that they know what they’re doing, they’re transparent, and they won’t try to do more than what you asked them to do. If your trusted advisor only started investing in 2021 after they read about GameStop on Reddit, they may not have the experience or gravitas to take care of your money.

Then, you need to make sure they are charging you a reasonable amount. If they are commission based, you have to watch out that they are not just taking action in your account to generate more fees. If they are fee-based as a % of how much money you are investing with them, you need to make sure they are low.

It’s hard to justify spending more than 1% of your assets on fees with an advisor. And if their strategy is simpler, such as an indexing strategy or a somewhat more diversified ETF strategy, the fees should be lower. They are doing real work in each of these cases, but putting you in planned passive strategies should not command a high fee.

The last con of working with an advisor is because even if they’re a superstar, it’s hard for them to grow your money more than you would yourself in the indexing strategy. A 1% fee for an active stockpicking strategy means that your advisor has to do 1% better than the market over the long term. That doesn’t sound like much, but it adds up.

Learn how to invest yourself

The last road available to you is to actually learn how to invest yourself.

I should be clear about two things here: first, like Warren Buffett said earlier, most people should just index. Second: I should probably index as well. But, I enjoy investing, and so I am in the ‘invest for myself’ category.

Learning how to invest beyond an indexing strategy means actively picking either ETFs or stocks to buy for your portfolio. You then have to decide whether to sell them and when, how many stocks you want, how to handle dividends, and so on.

Benefits to learning how to invest yourself

This path can be the most rewarding of the three paths. Not financially rewarding, necessarily – it’s just as hard for you to beat the market as it is professionals, even if you don’t charge fees.

But learning how to invest yourself can be rewarding for a number of reasons:

• You have control over your financial decision making
• You learn new skills, both directly financial like how to evaluate businesses and critical thinking about all sorts of new information
• You get a window into the world – investing involves ownership of small pieces of real businesses, and you can learn about trends or even apply trends you are observing to your investing.
• Investing is a great place to practice and improve your decision making, with real feedback and results
• You don’t have to rely on or pay anybody else to control this part of your financial future.
• It’s fun if you like being competitive, or challenging yourself

As a way to grow personally and to learn about the world, learning how to invest yourself can be great.

Cons to learning how to invest yourself

For all that, this is the option that the least number of people should choose.

• It’s hard to do better than option 1, or indexing. Ultimately investing is all about your money and what’s best for your future.
• It can be stressful when you make mistakes – and you will, we all do – or when the market goes against you even when you do good analysis. Controlling your stress is a big part of having success as an individual investor, and comes at a cost.
• Investing takes a real amount of time. It doesn’t have to be a full-time job, and it is not daytrading. But I would loosely estimate that you need to spend at least 10 hours a month on investing once you have spent all the necessary time to have a basic idea about what you’re doing. So it’s a real commitment.

Obviously, I’ve gone down this path, and I’m not going to snow you with false modesty. It is an attainable path, and you can go down it. The key is that you believe you will enjoy learning how to invest. If you do, you’re more likely to have personal success and financial success.

The most important thing is to start

I’ve presented these three roads as stark choices, but they’re not mutually exclusive. You can start your investing journey by indexing or working with a professional. Then, you can dip your toes into active investing, saving up, say, 5% of your investing assets to manage yourself.

A Short Investing Guide’s How to Start Investing course culminates in a “How To Index” post. If you stop there, I would be happy for you, that’s all you need to get started.

For those of you who want to learn more, the other courses on A Short Investing Guide will be ready and waiting. Maybe we’re crazy for going down that road, but done right, it can be a fun ride.

Check out our post on the right investing mindset – no matter which road you’re on – and subscribe for more posts!